There was a time when I thought the optimal goal of financial planning was to collect vast amounts of information, boil all of that information down to an extensive list of assumptions and finely-tuned projections, and then to “click a button” and calculate precisely what a client should do based on those assumptions.
I thought that was the most professional, responsible, logical, and most importantly, helpful, form of planning that could be done. But I was wrong.
Why? Because such planning has the effect of creating a presumption of precision, an overconfidence in the proverbial Plan A that leads to doubt in the inevitable Plans B and C, or even a despair that leads to the abandonment of planning altogether.
Here’s how Nobel prize-winning economist, Friedrich Hayek, put it:
“I prefer true but imperfect knowledge, even if it leaves much indetermined and unpredictable, to a pretense of exact knowledge that is likely to be false.”
This underscores something that is true in the practice financial planning and beyond: Life is “indetermined and unpredictable,” and it often requires us to make meaningful and challenging decisions based on “imperfect knowledge.”
I think we can do a better job acknowledging just how true that is in financial planning.
For example, markets are highly efficient and growing only more so. We have a couple centuries of data that have and will be mined, enabling investors to craft portfolios with a higher degree of confidence than at any time in the past. What remains unchangeably unknown, however, is what the stinking markets are actually going to do in the future. This year, next year, a decade from now. Nobody actually knows, and if they claim to they’re selling you something that is more likely to enrich them than you.
There are those who’ve done all investors well by applying a scientific approach to portfolio management, but “the science of investing” is a misnomer. However well formed, every investment philosophy must still be followed by the word “hypothesis,” and it always will be.
Fuzzier still is that no matter what a portfolio does and why, there is a who holding it, and that investor’s response to whatever the portfolio does is at least as “indetermined and unpredictable” as the portfolio itself, a veritable font of “imperfect knowledge.”
Hypothetical assumptions of risk tolerance, while helpful, are still worth little more than the whim required to choose the “I’d stay invested if my portfolio dropped 20% in one year” box.
Even an individual investor’s past response to market movements, while more accurate than a hypothetical scenario, are no indicator of future responses—because few stimuli, however predictable, are identical, and even if they were, we don’t really know how we’re going to respond until it happens, because we are ever changing. Furthermore, your response to market stimuli could have as much to do with the argument you just had with your spouse or the compliment you just got from your boss than your “risk tolerance” or belief in Modern Portfolio Theory.
What other assumptions are changeable in financial planning?
Inflation; local, state, and federal taxes; local, state, and federal laws; FAFSA and college admissions; life expectancy and disability; health and the cost of healthcare; virtually everything you could possibly imagine; and, again, you (yes, even if “you” are a financial advisor).
I want to be clear that I’m not saying we shouldn’t plan, that we shouldn’t do our best to rifle in on assumptions that will help us decide on meaningful courses of action that almost certainly have a higher probability of favorable outcomes. I’m just saying we should be careful to avoid the presumption of precision.
We should recognize that there are only three guarantees in financial planning—surprises, change, and failure. Fortunately, each of these oft-feared factors comes with an antidote:
· Surprises are accommodated with margin.
· Change is navigated elegantly with flexibility.
· And failure is transformed by grace.
In accommodation of all these unknowns and “unknowables,” we’re better served to develop plans that employ flexibility and that anticipate contingencies. It’s not a concrete financial plan that we need, but ongoing, iterative, calibrated financial planning.
Lastly, let’s spend less of our time and effort focusing on the longer-term elements of financial planning over which we have little-to-no control—which kinda feels like the majority of financial planning most days—and more on the shorter-term elements over which we have more control, our individual life planning.